“Capital Reversal” Creates Serious Difficulties for the Neoclassical Theory of Interest

In the course of the Cambridge debate it was the reswitching and capital reversal paradoxes which cast the deepest shadow upon the mainstream neoclassical theory of distribution. Yet, as we shall see, these paradoxes present no problem at all for the explanation of interest contained in the Misesian theory of capital and interest.

The problem posed for the neoclassical theory by the phenomenon of ‘capital reversal’ is well known. Capital reversal occurs when a change in the rate of interest is associated with a seemingly ‘perverse’ change in adopted production technique — for example, when a reduction in the interest rate implies a switch to ‘the less, not the more, time-consuming, or roundabout or capital-intensive technique’ (Yeager, 1976). The capital reversal is at least theoretically possible was conceded by major exponents of the neoclassical position in the 1960s (Saumelson, 1966; Ferguson, 1969). That this concession implies serious difficulties for the neoclassical view of interest as the supply-and-demand price of a productive service, has been emphasized by many writers.

—Israel M. Kirzner, introduction to Essays on Capital and Interest: An Austrian Perspective (Cheltenham, UK: Edward Elgar Publishing, 1996), 7.